Europe’s Debt Crisis Gloom Gives Dollar a Warm Afterglow

By Nicholas Hastings

Bloomberg News

The dollar’s prospects are getting brighter and brighter. And it is nearly all thanks to the euro zone.

The success of recent U.S. Treasury auctions, a further slide in 10-year U.S. Treasury yields and a likely rise in this week’s Treasury investment data all bear witness to the increased interest in the U.S. currency.

Although the U.S. Federal Reserve remains cautious about the future of the U.S. economic recovery, warning that there are still risks ahead, its more upbeat assessment after the latest open market committee meeting this Tuesday was enough to reduce market expectations of another dose of quantitative easing just now.

As Commerzbank put it: “With every recently positive data publication QE3… seems to move further into the sunset.”

Although this lowered risk of U.S. monetary easing should give the dollar some support, the U.S. currency is probably more of a front-runner because of the negative impact the euro zone debt crisis is having on the euro zone itself as well as on the rest of the world.

Instead of boosting market confidence, last Friday’s summit accord among European leaders to tighten and coordinate their budget discipline is proving a major disappointment.

Many political parties within the euro zone are baulking at the terms, making it likely that the accord itself may never get approval or ever be implemented.

With German Chancellor Angela Merkel still objecting to an increase in the bailout fund for peripheral debtors and some central banks, including the Bank of Japan and the German Bundesbank, questioning plans to provide more money to the International Monetary Fund backstop funding to prevent a sovereign default still shows little sign of being put into place.

Even plans for Greece’s private sector bond holders to take a 50% hit on their loans are proving difficult to complete, leaving the next tranche of Greece’s bail-out program at risk.

With Moody’s Investors Service Inc. issuing a fresh warning that the euro zone could soon lose its remaining triple-A credit ratings, there are signs that even those central banks that might have still been diversifying their reserves into the euro from the dollar are starting to reconsider.

There is also evidence of an even broader shift into the dollar from other high-beta currencies as investors start to worry about the impact the euro-zone debt crisis is having on global growth.

Capital flows into the Far East, including China and India, have slowed down markedly in recent weeks putting their currencies under pressure.

Even Australia is now worried with the Reserve Bank of Australia’s deputy governor Ric Battellino warning of the spill-over effects from the euro-zone downturn.

Whereas other safe haven currencies, such as the Swiss franc and even the Norwegian krone, may have benefited alongside the dollar in the past, there is little sign of them rising now as the euro-zone debt crisis appears to be entering a new and even more dangerous phase that makes the dollar even more attractive.